Institutions and Impersonal Exchange: The European Experience

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Institutions and Impersonal Exchange The
European Experience

• Avner Greif
• Stanford University

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Based on chapter 10 in

• Institutions and the Path to Economic Modernity
• Lessons from Medieval Trade
• 2005 (forthcoming). Cambridge University Press.
• Downloaded draft is on my Stanford webpage

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Market development

• The institutional evolution that enabled
  increasingly more impersonal exchange in some
  economies but not in others.

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A difficult evolution

• Contract enforcement institutions
• Personal exchange Reputation. Low FC, high MC.
• Impersonal exchange Law. High FC, low MC.
• Lowest welfare in the intermediate case.
• A chicken and an egg problem?
• Providing impartial Justice
• Rendering coercive power socially beneficial.

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Background the commercial Revolution, 1050-1350

• What were the institutions, if any, that
  supported impersonal exchange characterized by
  separation between the quid and the quo over time
  and space?
• E.g., credit, future delivery, etc..

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Impersonal?

• Transacting does not depend on
• expectations of future gains from interactions
  among the current exchange partners
• nor on knowledge of past conduct
• or the ability to report misconduct to future
  trading partners.

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Legal contract enforcement by the state?

• No effective central legal enforcement.
• Local courts.
• Partial, representing local interest.
• Hence, economic history no impersonal exchange
  prior to the rise of the State.

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Thinking outside the box

• This conclusion ignores the historical context.
• The European communes.
• Extent state like community like.
• Did communes provide the foundation for an
  institution that supported inter-communal
  impersonal exchange?

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The Community Responsibility System

• Each communal court held each and every member of
  another community legally liable for the
  inter-community contractual obligations of any
  other member.
• Economic reputation and coercion complemented
  each other.

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The Credit (Trust) Game set-up

• Repeated, overlapping generation, complete
  information game.
• Each player trades for T-1 periods, retires for
  one period and is then replaced.
• NL lenders and NB borrowers (NL gt NB). Random
  matching. No re-matching. Private information.
• The time discount factor is d?. Reservation
  utilities 0 to borrower and r gt 0 to lender.

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Moves and Payoffs
Borrower. If pays (l i, g) If cheats(0, G) i
gt r, g gt 0, G gt g, G lt g I i
Borrower. Initiates matching
Matching. If lender doesnt lend (l r gt 0,
0). If lender lends game progress
An abstraction that captures what we want. E.g.,
July 1190 Two Genoese bought cloths from a
merchant from Piacenza with one year to pay.
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Analysis

• No equilibrium with lending.
• Finite Horizon.
• Information regarding past conduct
• Strategic reasons.
• Technological reasons.
• Information regarding identities.

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Add communities

• A borrowers community. A lenders community.
• Each has a monopoly over coercive power in its
  territory. Lenders court Borrowers court.
• All lending and repayment are made in the
  lenders community.
• A courts payoffs? Net present value of the
  payoffs of the communitys living members.

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Time/action line
LC can verify at cost Cl LC can impound from
IB(t), g d gt 0.
Borrower travels or not.
Borrower pays or cheats.
Matching. Lender lends or not.
Lender can complain at personal cost c.
BC can verify, CB. Can fine, f 0. Can transfer
x f.
LC can return impound goods. Can distribute x.
Note LC denotes the lenders court BC denotes
the borrowers court.
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Comments

• Bankruptcy constraints.
• Courts actions are public information.
• Ability to verify past actions.

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In a subgame perfect equilibrium with lending
(4 players)

• Compensation - borrowers court will compensate
  if needed.
• No abuse of power - the lenders court does not
  confiscate all goods.
• Information lender is motivated to report
  cheating.
• Deterrence a borrower is deterred from cheating.

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Proposition 1 (harnessing coercive power) If

• 1 (compensation - BC)
• 2 (no abuse - LC)

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Then

• there is subgame perfect equilibrium with lending
  on the equilibrium path.
• In which
• a cheated lender gets i l c (information)
• the transfer is x i l c CL
• the fine is f x CB (deterrence)
• Intuition Nash reversion.
• Eq. survives identity verifying organizations.

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A CRS can provide

• Institutional foundations of impartial justice.
• It motivates those with a (legal) monopoly over
  coercive power to dispense impartial justice.
• Institutional foundation for the market.
• It enables impersonal exchange.

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But is it for real?

• The CRS is a theoretical possibility.
• But was it also a historical reality?
• Evidence?
• Direct.
• Indirect.

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Strategy of collective responsibility charters
within a political unit

• A charter to London, between 1130 and 1133, by
  Henry I
• "all debtors to the citizens of London discharge
  these debts, or prove in London that they do not
  owe them and if they refuse either to pay or to
  come and make such proof, then the citizens to
  whom the debts are due may take pledges within
  the city either from the town or from the village
  or from the county in which the debtor lives."

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Strategy of collective responsibility treaties
across political boundaries

• The King Henry III of England (1266) to the
  merchants of Lubeck (Germany) that
• they or their goods within the king's power
  shall not be arrested for any debt whereof they
  are not sureties or principal debtors unless the
  debtors are of their commune and power and have
  failed to pay in whole or part and the said
  merchants of Lubeck, by whom the said town is
  governed fail in justice to the men of the king's
  land and power, and this can reasonably be
  proved."

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Representative?

• The law of the land in England, Florence, and
  elsewhere.
• English charters - 65 percent of known urban
  population is covered.
• Florence (12th 13th) 44 commercial treaties.
  33 are concerned with the CRS.

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Evidence of the complementary part of the
strategy

• holding one liable for the cost his actions
  abroad imposed on other members of his community
• Double penalty.
• Sell the property of individual who failed to
  compensate.
• Expel him after insufficient compensation.

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Smoking gun?

• The Law of the Land is not necessary a part of an
  institution.
• Did merchants and courts believe in the
  relationships and possibilities the model
  highlights?
• Did the beliefs prevail that the above rules
  would be followed and have the above impact?
• Was the CRS an institution (rather than rules)?

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To evaluate

• Common sense and historical evidence suggest the
  relevance of imperfect monitoring. (Green and
  Porter.)
• A lender can believe that he was cheated.
  (Agents signals are private.)
• The courts can disagree whether cheating had
  occurred. (Courts signals are public
  information.)

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Implications?

• Under conditions similar to the above, there is a
  Perfect Bayesian equilibrium with lending.
• On the equilibrium path there would be
• Accusations.
• Disputes court cases.
• Cessation of trade for a finite number of years.

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We should observe smoking gun on the equilibrium
path

• Many anecdotes
• Students seeking exemptions. Bologna (1155),
  Florence (1171).
• Court cases (sometimes resolved).
• Beatrice of Florence vs. Ubaldo Viscounti of
  Pisa.
• The 1214 treaty between Pisa and Florence.

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Systematic evidence?

• E.g., Florence. 1280 to 1298
• 36 disputes, confiscations, or trade cessations.
• At least 25 towns.
• As far away as Spain (Aragon) and England.

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Systematic evidence?

• England
• Mayor of London (1324-33) commercial letters.
• Numbers reflecting the CRS 59/139 of internal
  and 15/50 external.

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Puzzling Organizational Features

• Champagne Fairs.
• Organized as meeting places for traders from
  different communities
• residences, storage facilities, consuls, scribes,
  
• law was personal not territorial.

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Rationale

• Identity-certifying organization and
  arrangements.
• If community liable, it should have legal
  authority.
• Similar arrangements in smaller fairs.

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Comparative Advantage in Contract Enforcement

• Theoretically, the CRS confers an advantage to
  Fairs without trading communities.
• The rationale communes bear cost for enforcing
  non-members contracts.

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Historically

• Communal regulations and charters restricting
  confiscation for non-members.
• International fairs did not have communities of
  international merchants.

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Grace period

• Proposition 1, condition 1 (compensation - BC)

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Endogenous institutional decline

• Late 13th century systematic attempts to abolish
  the CRS.
• The processes that the CRS fostered
• Undermined its self-enforceability,
• increased its economic costs,
• and eroded its intra-community political
  viability.

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Specifically,

• Increase in inter-community interactions, and the
  growth in size, number, and heterogeneity of
  merchants' communities,
• Decreased falsification costs.
• Increased costs of strategic uncertainty?
• Particularly in large cities.
• Entailed different interests within communities
• Costs and benefits to wealthy and poor merchants.
• Wealthy retain CRS regarding property protection.

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Indeed,

• Large cities abolished the CRS first. (Italy,
  England, Flanders.)
• England. Rich merchants sought royal exemptions.
• When rich merchants gained political control
  (e.g., Florence, 1276)
• Retained the CRS only with respect to property
  protection.
• When the Italian republics turned oligarchic

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Political institutions determine possible
responses

• Italy No alternative.
• The Family Firm.
• Germany No alternative.
• Enforcers for hire Feuds.
• Smaller, homogenous cities CRS.
• England the Crown.
• Individual Legal Responsibility (1275).

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A process, not an event

• Informal
• The 15th century borrower from Frankfurt.
• Formal
• English charters with CRS after 1275.
• The Mayor of Londons letters (1360-70).
• 55 out of 159. (35).

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The Birth of the International Economy

• 1324 to 1333 larger fraction of domestic than
  international letters reflects the CRS.
• 1360 to 70 45 percent more international cases.
• National boundaries began to matter!

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Conclusions Economics

• The importance of institutions combining coercion
  and reputation.
• Conduct versus identity in reputation models.
• Is voluntary collective responsibility always
  (economically) optimal?

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Conclusions Economics

• The centrality of collective responsibility in
  European institutional development.
• Other societies?
• The uniqueness of European contractual and
  organizational development.
• E.g., letters of the fairs, negotiable
  securities.
• The modern firm as a nexus of responsibility?
• The impact of inter-jurisdictional trade on
  domestic institutional development.

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Conclusions - political

• Neither state-centered development nor
  community-centered development.
• Communes, possibly in the context of a state
• Italy economic and military competition.
• England / the Low Countries only economic
  competition.
• Organic political growth. Did communes influence
  the rise of states with Rule of Law?
• Next talk.